The different types of Director’s Loan
A director’s loan is a sum of money you take from your company’s accounts that cannot be classed as salary, dividends, or legitimate expenses.
In other words, it is money that you (as a director) borrow from your business and repay at a later date.
So, why would a director borrow money from their business?
Taking out a director’s loan can provide access to capital that you are currently receiving as salary or dividends. They are typically used in the short term to cover one-off expenses.
They shouldn’t be relied on as a regular source of cashflow because they can incur heavy tax penalties. Instead, they’re most effective as a ‘reserve’ source of funding.
Aside from this type of director’s loan, there’s another kind that involves a director lending money to the business, such as to alleviate cashflow pressures. From this type of director’s loan, the director becomes one of the company’s creditors.
How to use a Director’s Loan
Technically the money that a director borrows from a company under a director's loan can be used however they see fit. But as mentioned, it's important to remember that there are serious tax considerations that occur when you do this.
If you, as a director, do need to borrow funds from your business, there’s no legal limit on the size of the loan.
But we recommend taking the following steps to ensure you’re using the scheme efficiently:
Take into consideration how much capital you really need to borrow by drawing up a budget and a spending roadmap. If you borrow money that the company can't afford, it could lead to cashflow problems for the business, in the near or distant future.
If you regularly borrow money from the company under a director’s loan, HMRC might decide that this should be treated as a salary. If this is the case, they can introduce income tax liabilities for these funds.
If the total sum of the director’s loan being withdrawn from the company exceeds £10,000 at any one time, it will be automatically deemed as a Benefit in Kind (BiK).
Alternatively, if you want to provide capital for your company, this form of director’s loan is treated the same as any other loan. You and your company are separate legal entities, so the money you put into the business is treated as standard - the company commits to repaying the full amount.
What is a Director’s Loan Account?
Simply put - if you personally fund your limited company, or withdraw money from it for personal use, and it isn't classed as a salary, dividend, or expense repayment, it's called a director's loan.
Each time a director’s loan takes place, you’ll have to keep record of it for accounting purposes. The record of these transactions constitutes a director's loan account (DLA).
Each director in the business has their own director's loan account, which appears on the company's financial records.
Your director’s loan account should record every transaction which shows company money being withdrawn or used for personal reasons (that isn't your salary or a dividend payment).
In turn, personal money that you allocate to the company, or put into it, including repayments you make to your director's loan account.
Recording transactions in your Director’s Loan Account
Your director's loan account transactions could appear in the form of:
A cash transfer from the company bank account to the director’s personal one, or vice versa.
Using a company card to pay for personal expenses or using a personal card to pay for business expenses.
If you owe the company for a director's loan, paying for business expenses with your own cash reduces the amount that you owe.
As a rule of thumb, any expense that isn't solely for the business is considered to be a personal cost, so be sure to record them in your director's loan account.
When you use your director's loan account, it will show either a debit or credit balance depending on whether the director is receiving for providing the loan.
When you are receiving the Director’s Loan and owe the company money
A debit balance on your director's loan account means that you owe money to the company. Like any loan, it’s best to get this repaid at your earliest convenience.
If the director is also a shareholder, this balance can be cleared as if it were a dividend, but only if the company is making a profit which allows for this.
So, if the director’s loan Account is overdrawn by £5,000 (which means it would show a £5,000 debit balance), the company could declare dividends of £5,000 to cancel out the amount.
In this instance, the director doesn't actually receive the £5,000 payment, but the 'transfer' is reflected in the company's bookkeeping. This amount will be subject to dividend tax, which the director will have to cover using their personal funds.
So, in a nutshell:
The director's loan account will be credited with £5,000 to reduce the balance to zero.
Dividends will be debited with £5,000.
If you reach the end of your company's fiscal year - and the loan amount hasn't been repaid or cleared as if it were a dividend – the sum may be subject to S455 Corporation Tax.
When you are providing the Director’s Loan and the company owes you money
So we’ve established that director's loan accounts can work both ways, and a director can lend personal funding to the business if need be.
If your director's loan account shows a credit balance instead of a debt, it means that the company owes money to you. The good news is - the recipient company won't have to pay Corporation Tax on the amount that you lend to it, and you can take the money back at any time.
Charging your company interest on a director's loan
The interest payments will be classed as a business expense for the company.
However, it’s worth noting the following key points:
Your business will need to deduct 20% income tax when paying back the loan interest to the director. These deductions need to be reflected on a form called a CT61, and reported to HMRC every quarter.
The remaining amount will be paid to you – the director - but will be classed as personal income, so you'll need to present them on your Self Assessment tax return.
Director’s Loan Accounts and tax
If possible, when your director's loan account is overdrawn, you should aim to repay it before the end of the company's fiscal year. The end of your fiscal year is also referred to by HMRC as the end of your Corporation Tax accounting period.
If you don't repay a director's loan within nine months and one day from the company's fiscal year end, you will incur tax penalties. This is due to the fact that the amount you borrowed hasn't yet been taxed, either through the company or your own tax return.
The way that HMRC deals with tax when directors take loans from their business depends on how much you borrow at any one time. The important figure here is £10,000.
If your director's loan is less than £10,000 in a financial year, then the tax that you pay depends on the date you pay the loan back. The key is the nine month and one day window after the end of the company's fiscal year.
Tax liabilities if your director's loan exceeds £10,000
If the total amount which you borrow from your company under a director's loan exceeds £10,000 at any point during the fiscal year, it will be automatically classed as a Benefit in Kind (BiK), meaning that both the director and the company will be liable to pay tax on the amount.
The company (at which the director is appointed) must complete a P11D to inform HMRC of the benefit. The company will then pay Class 1A Employer's National Insurance on the total amount of the loan, at a rate of 13.8%. The loan will need to be reflected in your Self-Assessment tax return.
If you’re wondering whether you can avoid these tax liabilities by paying back your director’s loan before your year-end, and then withdrawing it again after the year-end has passed – this isn’t a viable solution. In fact, it’s just plain tax avoidance.
To stop directors from trying to skip out on tax this way, the government implemented a 30-day rule, whereby if you repay one loan to your company, you must wait at least 30 days before you can take out another one.
If HMRC determine your director’s loan account activity to be indicative of tax avoidance, they won’t hold back on recouping these tax liabilities alongside some serious penalties.
That covers just about everything you need to know about the different types of Director’s Loan and how they work to alleviate cashflow pressures for both businesses and entrepreneurs.
If your company could benefit from having a Director’s Loan in place, or require this funding tool in the future, it’s best to have an accountant onboard that’s experienced with Director’s Loan Accounts.
At Jump Accounting, we specialise in Advisory Accounting services for businesses of all stages - such as the Director’s Loan scheme. Even if you don’t need to set a Director’s Loan up now, our team of proactive accountants can always suggest when it might be most efficient to implement.